F494 SUPPLEMENTAL PROBLEM 2 Suppose a US-based Multinational Corporation (MNC) c

Question

F494 SUPPLEMENTAL PROBLEM 2 Suppose a US-based Multinational Corporation (MNC) can earn 2.5% on a marketable security and uses such investments to tie up excess cash until needed. The company is considering investing in securities denominated in Czech Koruna (CZK) as they pay a higher nominal return that US Dollar (USD) denominated securities. Expectations are that the Czech Koruna will depreciate against the USD by 4.5% during the next year. What is the minimum NOMINAL RETURN needed on CZK denominated securities to warrant investment?

Explanation / Answer

NOMINAL RATE IN CZK DENOMINATED SECURITIES

= (1 + RATE IN US)*(1+ DEPRECIATION) - 1 = (1+0.025) (1+0.045) - 1 = 0.071125 = 7.1125%

ANSWER : 7.1125% (THUMBS UP PLEASE AFTER READING EXPLANATION)

EXPLANATION :

INTEREST EARNED IN US @2.5% ON $40 (ASSUMED VALUE) = $1, SO TOTAL AMOUNT RECEIVED AFTER A YEAR = 40 + 1 = $41

NOW SUPPOSE THE CURRENT EXCHANGE RATE = 25 KORUNA = 1 $

A PERSON INVESTS $40 IN KORUNA TODAY, SO HE WILL RECEIVE 1000 KORUNA

INVEST AT 7.1125% FOR A YEAR, YOU WILL RECEIVE = 1000 + 71.125 = 1071.125

CONVERTING INTO DOLLAR, KORUNA HAS DEPRECIATED BY 4.5%

SO NEW EXCHANGE RATE WILL BE 25*(1+0.045) = 26.125 KORUNA =1$

SO AMOUNT IN DOLLARS = 1071.125/26.125 = $41 = EXACTLY SAME AS RECEIVED IN DOLLAR

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